All Eyes on Margins and Inflation
Telemus Weekly Market Review April 11th - April 15th, 2022
Stocks continued to slide marking the third straight week of declines following the market’s late March bear market rally. The S&P 500 index dropped -2.1% in the holiday shortened week. Bonds also fell as interest rates continued to rise, pressuring prices.
The economic headline for the week was the March inflationary reading, where the Consumer Price Index (CPI) spiked by 1.2% for the month, leading to an annualized inflation rate of 8.5%. This was exaggerated by higher gasoline prices. The Core CPI index, which excludes more volatile food and energy categories, was up 0.3% for the month. This was a more muted reading than prior months. Those looking for a reason to be optimistic about inflation cheered the subdued core CPI reading, with some even making the call that inflation may have peaked. While we like optimists, we’ve longed believed there will be volatility in monthly inflation readings as cyclical elements come in and out of the numbers. Our view is its way too early to make a call on inflation hitting its peak.
As the brief optimism that set into markets in late March has started to burn off, what we’ve seen is rising rates among longer maturity bonds. The yield curve, which briefly inverted in late March, is now steepening. Expounding upon this jargon, we had seen the yield on a 10-year Treasury fall below that of a 2-year Treasury in late March. Many view this as a sign that a recession may be on the horizon. Bonds have quickly reversed course and as of the market close on April 14th, the 10-year Treasury yield of 2.83% was 0.37% above the 2.46% yield on the 2-year Treasury bond.
Tying this back to stocks, we’ve seen a bit of a reversal in the equity market thus far in April. These past two weeks, higher interest rates have been putting pressure on equity prices by compressing multiples. Large cap, U.S. equities are lagging other equity categories. Since the most recent March 29th peak, the S&P 500 is down by -5.1%, whereas developed international stocks have only lost -3.4%. More impressive are emerging market equities, which have dipped only -1.5% lower over this span.
As we look forward to the remainder of April, all eyes will be on corporate earnings reports. The market is concerned about the ability of corporations to hold on to record profit margins given inflationary pressures across supply chains, labor, and commodity prices. This past week we saw a few earnings reports trickle in, largely from banks. Results were mixed and we would expect the puzzle to come into form over the next couple of weeks.
In this environment, having focus on price and earnings is important. We do believe that not all companies are going to be able to hold margins in an environment with elevated inflation. In addition, rising interest rates have historically proven to be a headwind on price-to-earnings multiples. As such not overpaying for a stock becomes more critical. A cautionary tone to the market is likely to remain as we await greater clarity on inflationary trends, how those feed into interest rates and ultimately the impact on corporate earnings.
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The Consumer Price Index (CPI) measures the performance of US inflation (not seasonally adjusted) which is the rate of change of consumer goods prices. It measures of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. Indexes are available for the U.S. and various geographic areas. Average price data for select utility, automotive fuel, and food items are also available. The data is from Bureau of Labor Statistics. The value of the current month CPI is estimated by the average value of the previous two months CPI. The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities. There is over USD 11.2 trillion indexed or benchmarked to the index, with indexed assets comprising approximately USD 4.6 trillion of this total. The index includes 500 leading companies and covers approximately 80% of available market capitalization. An index is not a security in which an investment can be made, as they are unmanaged vehicles that serve as market indicators only and do not account for the deduction of management fees and/or transaction costs generally associated with investable products.
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Matt joined the Telemus team in 2018. As Chief Investment Officer, he leads the firms the investment process and research effort. Matt has experience as an equity analyst and portfolio manager and has advised corporate pension plans on their manager selection. He’s been quoted in Money Magazine and Barron’s.